THE WEEK AHEAD: Playing poker with the Fed

3 January 200211:43 am AEDT

Was Fed Chairman Alan Greenspan trying to warn the market that an interest-rate hike could be on the horizon this week during his Humphrey-Hawkins testimony? Or was he just being his mysteriously cautious self?

Depending on your point of view, the answer may determine the market's fate in the next month ahead of the Fed's next policy meeting. It's a sad state of affairs that when corporate earnings are skyrocketing, the market bases its mentality on what amounts to deciphering the Fed.

"The market is still trying to figure out exactly what Greenspan said," Arun Kumar, senior U.S. equities strategist at Lehman Brothers. "The bond market seems to have taken the testimony as negative."

In his semi-annual congressional testimony Thursday, Greenspan said the Fed would act "promptly and forcefully" to stifle inflation, and added that the surge in stock prices could be overdone.

"The bond market is still nervous about an interest-rate increase," said James Volk, co-director of institutional trading at D.A. Davidson.

For the week, the Dow plunged 218 points to close at 10,910.96 while the Nasdaq plummeted 172 points to 2,692.41.

Next week, investors will pay close attention to the Employment Cost Index report which could provide a clue as to how the Fed will evaluate interest rates.

The irony of this week's pullback is that earnings from the likes of Gateway Inc. (NYSE: GTW), America Online Inc. (NYSE: AOL), Microsoft Corp. (Nasdaq: MSFT) and International Business Machines Corp. (NYSE: IBM).

"The earnings story has been discounted. The fact that earnings are coming in positive isn't news to anyone anymore," Kumar said.

America Online's story is perhaps the most interesting. After earning 13 cents a share in its latest quarter, AOL beat the Street estimate by 2 cents a share.

Amazon.com Inc. (Nasdaq: AMZN) met analysts estimates in its second quarter, losing $82.8 million, or 51 cents a share, on sales of $314.4 million. But that $314.4 million is only a 7 percent jump from the first quarter.